Heightened competition generally leads to better products, more choice and lower prices. But, with the closure of certain key lenders, tighter lending rules and changing pricing strategies, the mortgage industry risks losing competition.
In the next few years, we could find that the broker channel proves essential to maintaining a healthy market balance. The reasons for that follow here.
Interestingly, competition doesn’t always lead to the lowest rate or best deal in the mortgage and banking markets. Getting the lowest-cost mortgage also takes research.
When a consumer chooses to work with a mortgage broker, they are outsourcing this research (i.e., comparison shopping) to a qualified expert. The broker then uses his or her knowledge of the market, access to multiple lenders and evaluation of the client’s unique needs to identify suitable options.
On average, brokers deal with 5.9 lenders for each client, according to a 2005 Taddingstone report. These lenders all vie for the broker client’s business, which in turn fosters more competitive rates and products.
That competition also reduces each lender’s individual leverage.
In fact, research shows that a lender’s capacity to exercise market power on a borrower depends not only on differentiation from competitors, but also on the borrower’s ability to generate competitive outside offers. (A related report)
Recent studies find that consumers who use mortgage brokers save an average of 19 basis points on their interest rate. It’s surprising then that CMHC’s latest Mortgage Consumer Survey found that a whopping 73% of mortgage consumers still choose to not use a broker. In large part, this may be due to a lack of awareness about what brokers really do.
Mortgage brokers have long bridged the gap between lenders and consumers, but they became quasi-mainstream only in the late 80s. That’s when various trust companies (including FirstLine Trust, later a division of CIBC) and TD Bank, started using brokers as a variable cost alternative to in-house mortgage origination. In turn:
Lenders benefited from increased distribution without having to support a high fixed cost base (i.e., branches)
Consumers enjoyed bigger discounts off of bank posted rates. Through the discounted pricing model of brokers, consumers found significantly greater transparency.
“As competition in the housing finance market became more intense…Canadian consumers benefited from increasing choice in terms of rate and term options and payment features for their mortgage loans.”
She named virtual banks and mortgage brokers as the market’s new competitors.
Traclet also discovered something else. She found that, even when banks started to aggressively discount off their posted rates (from approximately 25 basis points in the early 1990s to 125 basis points in the mid-2000s), their posted rates actually ended up increasing. In other words, greater “discounts” did not necessarily decrease consumers’ effective mortgage rates.
In 2002, TD Canada Trust became the first big bank to adopt “no haggle” discounted mortgage rates. This was likely a strategic response to improve customer service through enhanced transparency. I also believe it was, at least partially, in response to the competitive nature of the broker and virtual bank channels. TD clearly saw these channels growing at an impressive rate. In fact, from 1997 to 2005, mortgage broker share increased from less than 10% to over 30%.
In recent years, we’ve seen lender numbers decrease, both inside and outside the mortgage broker channel. This is partly due to the recent global crisis which prompted some lenders to leave the Canadian market – including Accredited, GMAC, Wells Fargo, HSBC Finance, and others. It’s also the result of domestic lenders merging or shutting down certain business lines, including CIBC’s wind-down of FirstLine Mortgages, formerly the largest wholesale lender in Canada.
The rationale for CIBC’s decision was published in the Financial Post on June 10, 2012.
“… we are emphasizing our CIBC branded channels where we have an opportunity to deepen client relationships, have higher levels of client satisfaction and better NIMs (net interest margins). Our FirstLine brand does not support this strategy as the broker channel resulted in primarily single product client relationships.”
The term “better NIMs” implies greater profitability for the bank. This could come from additional cross selling, cost reduction, charging higher interest rates and so on. CIBC chose to focus on channels it believes can earn more profit.
Admittedly, this strategy may serve bank shareholders well. By cutting access to brokers and thinning the competition, banks can command higher interest rates. Yet, despite how banks position these moves (e.g., deepening “client relationships”), they reduce competition and could very well impact the value received by consumers.
Evidence shows that a strong broker market keeps lenders competitive and is in the best interest of consumers. Case in point is a report from the Bank of Canada that found:
“…borrowers are more likely to use a broker when there are many lenders. When there are many lenders, the [benefits] to hiring a broker are potentially higher since they have access to more options.”
Additional evidence comes from a separate Bank of Canada’s finding that banks do not treat all customers the same. Banks, for example, offer larger discounts to new customers than existing customers. They do so, again, to maximize profits when faced with reduced competition.
Canada has long been considered a country that puts the wellbeing of the collective ahead of the individual. Out of all the reasons to support mortgage brokers, perhaps the most compelling is that consumers are better off when the broker channel is strong.
History has shown that a formidable broker channel promotes lender transparency. This results in more aggressive pricing for all consumers, not just the best negotiators. Today, broker share hovers near 30%. One could imagine the savings to consumers if that number were closer to 50%.
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